ORDER
Pramod Kumar, A.M.
1. This is an appeal filed by the assessee and is directed against the order dt. 22nd May, 2001 passed by the CIT(A) in the matter of assessment under Section 143(3) of the IT Act, 1961 (hereinafter referred to as ‘the Act’), for the asst. yr. 1998-99.
2. In the first ground of appeal, the assessee has raised the following grievance : Interest on foreign currency depositsGross interest of Rs. 2,47,92,503
The GIT(A) erred in holding that only net interest and not the gross interest is exempt under the provisions of Section 10(15)(iv)(fa) of the Act.
3. So far as this grievance of the assessee is concerned, the material facts are like this. During the course of the assessment proceedings, the AO noticed that the assessee has claimed that interest received by the assessee on the foreign currency deposits with scheduled banks, amounting to Rs. 2,47,92,503, was exempt from tax under Section 10(15)(iv)(fa) of the IT Act, 1961 (hereinafter referred to as ‘the Act’). In response to AO’s requisition to show cause as to why only net interest income i.e. interest earnings as reduced by interest and other costs paid to acquire funds which were so placed with the scheduled bank in foreign currency deposits, not be allowed the exemption under Section 10(15)(iv)(fa), it was submitted by the assessee that the assessee bank has neither incurred any expenditure nor borrowed any amounts which can be identified as towards earning of interest exempt under Section 10(15)(iv)(fa). The assessee also placed his reliance on the judgment of Hon’ble Supreme Court in the case of Rajasthan State Warehousing Corporation v. CTT . None of these contentions impressed the AO. The AO was of the view that since the exemption is granted to only the income, the amount to be exempted has to be net of expenses and not the gross amount itself. It was also pointed out by the AO that in case contention of the assessee is accepted, it will result in absurd results because, on one hand, gross interest receipts will be exempt, and on the other hand, the expenses incurred to earn the interest income will be allowed as deduction in computation. Reliance was placed on Hon’ble Supreme Court’s judgment in the case of Escorts Ltd. v. Union of India in support of the proposition that effective deduction of an expenditure cannot be more than one hundred percent, while, if contention of the assessee is accepted, the effective deduction will be several times more because the entire income will be exempt from tax and entire expenditure will be allowable as deduction. The AO also relied upon the identical stand that he had taken for the immediately preceding year. Aggrieved by the stand so taken by the AO, the assessee carried the matter in appeal before the CIT(A), but without any success. The CIT(A) observed that it was a result of Hon’ble Supreme Court’s judgment in the case of Rajasthan State Warehousing Corporation Ltd. (supra) has been nullified by the introduction of Section 14A of the Act. He was of the view that if there is an income, which is not includible in the total income, any expenditure in relation to that income will cease to a deductible expenditure. The CIT(A) further observed that “if there is bank and it has borrowed money and purchased tax-free bonds, it will not get deduction for the interest paid”. The CIT(A) went on to add that “even if there is no co-relation, deduction of expenditure will not be allowed”. The assessee is aggrieved and is in second appeal before us.
4. We have heard the rival contentions, and we have perused the material on record in the light of applicable legal position.
5. At the outset, we may mention that the an identical disallowance made by the AO for the immediately preceding year did come up before a co-ordinate Bench of this Tribunal, and the Tribunal, while disposing of the said appeal and articulating its views through one of us (i.e., the AM), in the order reported as Addl. CIT v. Dresdner Bank AG (2006) 105 TTJ (Mumbai) 185 : (2005) 1 SOT 274 (Mumbai), observed as follows:
Whichever way one looks at it, the basic objection of the Revenue is that effectively only the net income i.e. eligible interest minus expenditure incurred to earn that interest, can be allowed exemption from tax. The objection, however, proceeds on the assumption that there is a cost of the funds which have been invested to earn the interest exempt under Section 10(15)(iv)(fa), but in the statement of facts, the assessee has made a categorical assertion that the assessee “has neither incurred any expenditure nor has borrowed any monies which can be identified as towards earning for the said interest”, and the CIT(A), on this basis, held that on these facts it was not open to the AO “to estimate the expenditure without any scientific basis”. We have noted that this finding of the CIT(A) has not been challenged by the Revenue. Once Revenue accepts this finding, as they have chosen to do in the case before us, the grievance raised before us is rendered purely academic. It does not merit any adjudication before us. In any event, no specific costs have been pointed out which have been incurred by the assessee to earn the eligible interest. We, therefore, decline to entertain this academic question i.e. whether exemption under Section 10(15)(iv)(fa) is to be allowed on the gross basis or net basis.
It was in this background that the appeal of the Revenue on this issue was dismissed. In the year before us, the assessee’s stand to the effect that no costs have been incurred has not been accepted by any of the authorities below and the CIT(A), in fact has gone to the extent of holding that even if there is no co-relation between the earning of interest eligible for exemption and the expenditure incurred, deduction of related expenditure cannot be allowed.
6. In our opinion, the grievance raised by the assessee does not correctly bring out the controversy. The real dispute is not on taxability on gross basis or net basis because the authorities below have held that effectively only net income is to be exemptedeither by invoking restriction of exemption on net income, or by invoking the disallowance of expenses incurred ‘on earning the tax exempt income. The AO has specifically invoked the disallowance under Section 14A of the Act. Therefore, the exemption being allowed on gross basis would not make any difference to the situation inasmuch, because of the corresponding disallowance under Section 14A for the expenditure incurred to earn the tax exempt income, the effective exemption will be on the net basis. However, in case the exemption is granted on the net basis, the expenses incurred to earn that exempt income i.e. net interest income, cannot suffer disallowance under Section 14A because such a situation will result in double jeopardy to the. assessee. That aspect of the matter is, however, academic, because, for the reasons we shall set out now, it is clear that exemption under Section 10(15)(iv)(fa) is to be granted on gross basis only.
7. We find that the language of the Section 10(15)(iv)(fa), which is reproduced below, is quite clear and unambiguous :
Section 10:
In computing the total income of a previous year for, any income falling within following clauses shall not be included :
…
…
(15) interest payable
…
…
(fa) by a scheduled bank, to a non-resident or to a person who is not ordinarily resident within meanings of Sub-section (6) of Section 6 on deposits in a foreign currency where acceptance of such deposits by the bank is approved by the RBI.
8. A plain reading of the aforesaid legal provision indicates that what is exempt under Section 10(15)(iv)(fa) is interest payable by the scheduled bank in certain conditions. The ‘interest payable’ has to be on the gross basis. Therefore, the exemption of interest has to be on the gross basis. To that extent, we agree with the assessee.
9. The matter, however, does not end here. The next thing is to examine the matter from the point of view of applicable disallowance under Section 14A, as is the case of the authorities below in their respective orders as well.
10. We have noted that none of the authorities below have carried out any exercise of identifying the expenditure which can be said to be incurred in relation to earning of the income exempt under Section 10(15)(iv)(fa). The references to disallowance under Section 14A by the AO has been made in a somewhat academic manner. He has not bothered to identify the expenditure incurred by the assessee in relation to this tax exempt income.
11. As for the observations of the CIT(A) which we have quoted earlier in this order, to the effect that, “if there is bank and it has borrowed money and purchased tax-free bonds, it will not get deduction for the interest paid” and that “even if there is no co-relation, deduction of expenditure will not be allowed”, we are not persuaded either. There can be no dispute or controversy about the position that when any expenditure incurred in relation to earning of a tax exempt income can be identified, the same is to be disallowed under Section 14A. What is, however, to be disallowed is the “expenditure incurred in relation to earning of an income which does not form part of the total income under the Act”. The proximate cause of disallowance is its relationship with the tax exempt income. Wherever the expense incurred has no relationship with the income not includible in the total income, there cannot be any occasion to invoke the disallowance under Section 14A. To that extent, we cannot, and do not, approve the reasoning of the CIT(A).
12. Having said that, we also deem it fit and proper to add that it is for the AO to identify the expenditure which can be reasonably said to have been incurred to earn a tax exempt income, before Invoking the disallowance under Section 14A. That exercise needs to be carried out.
13. In the light of the above discussions, we deem it fit and proper to remit the matter to the file of the AO for quantifying the expenditure incurred, if any, for earning the income exempt under Section 10(15)(iv)(fa). While doing so, the AO shall give due and fair opportunity of hearing to the assessee and shall decide the matter in accordance with the law and by way of a speaking order.
14. The first ground of appeal is thus allowed for statistical purposes in the terms indicated above.
15. An important question requiring our adjudication in this appeal is about the compass of a non-resident enterprise’s income which, for the purposes of Section 5(2)(b) of the Act “accrues or arises…in India”. This question is in particular context of dealings of such a non-resident enterprise’s branch in India, on one hand, and the non-resident enterprise or its branches outside India, on the other hand. In other words, the question requiring our adjudication is whether, under the Indian IT Act, 1961, the profits arising out of dealings of a foreign company’s Indian branch office, with its head office and with other foreign branches, is taxable in India or not.
16. The related, ground of appeal i.e. second ground of appeal, is reproduced below for ready reference :
Interest receivable from head office/overseas branches of the bankRs. 5,17,39,005
The CIT(A) erred in holding that the interest receivable by the Indian branch of your appellant from its head office/overseas branches is ‘income’ of your appellant taxable as such.
17. The grievance raised by the appellant lies in a very narrow compass of material facts. The assessee is a non-resident banking company incorporated in Germany, and operating in India through its branch office in Mumbai. During the course of assessment proceedings, the AO noticed that “the assessee has given a note to the computation’ of income that inter-branch income/ expenditure credited/debited to P&L a/c have been excluded while arriving at the total income since the Bank cannot be regarded as trading with itself i.e. having earned income or incurred expenditure by mere reason of Mumbai branch debiting/crediting the ledger account of the other branches outside India”. In response to AO’s requisition as to why the income from inter-branch transactions should not be brought to tax in India, the assessee reiterated that the branch and head office transactions are transactions with oneself and relied upon the decision of Hon’ble Calcutta High Court in the case of Betts Hartley Huett & Co. Ltd. v. CTT .
18. This stand, however, did not find favour with the AO. The AO was of the view that the income of the assessee would be covered by Section 9(1) of the Act. The AO was also of the view that if the branch and head office are to be viewed as one and the same thing, then there was no reason to file ‘return in respect of India operations’. The AO observed that it was accepted international tax law practice that income “accruing or arising” in a country is taxed in that country. The AO further took note of the factual position that in notes forming part of the computation of income “the assessee has mentioned that profits have been computed in accordance with the provisions of the DTAA (between India and Germany). The AO then referred to various articles of India Germany DTAA, and having analyzed the same, concluded that “these articles are very clear that the income of the assessee is quite independent of its head office” and that “the statute has made it mandatory to treat these as separate entities”. The AO also concluded that “the interest earned from NOSTRO would be deemed to have been accrued or arisen in India as it emanated from India operations of the bank”. The AO concluded as follows :
It is pertinent to note the figures in balance sheet of the assessee. The balance sheet shows that the entire deposit/borrowings of the Indian branch is from within India. The borrowings outside India is nil. The funds have been deployed to acquire assets in the form of advances, etc. It is evident that the assessee has obtained funds through deposits and borrowings in India. The assessee has no deposits or borrowings from outside India. Investment outside India are also nil.
The NOSTRO account is nothing but the bank account of the Indian branch in the head office. The interest carried on the balance is the income of the Indian Branch and credited to the P&L a/c of the Indian branch. In short, funds raised by deposits by the Indian branch and shown as liabilities in its balance sheet have been temporarily placed in the NOSTRO account before being brought into India for lending in the country. Interest on the same funds when they are brought to India and lent would be income in the hands of the Indian branch.
The funds in the NOSTRO account of the assessee are a part of the total funds of the head office. As far as the Indian branch is concerned, the interest in question is interest carried on the NOSTRO account. The interest is payable by the head office who is also a non-resident. This non-resident has a business connection in India and also uses part of its funds to lend to Indian business though its Indian branch.
It may be seen that source of deposits are the banking operations in India. The interest earned would be covered under the definitions of income accruing or arising directly or indirectly.
The head office or other office outside India are carrying out their business thought Indian branches. There are flow of funds from overseas branches. The debt incurred or moneys borrowed are used for the purposes of business or profession carried on by such person in India.
In our case, the Explanation to Section 9(1)(i), is applicable which states that the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. The same thing appears in Article 7(1) and Article 7(2) of the Double Taxation Agreement.
The argument of the assessee for the purpose of the Act, a non-resident is treated as one assessee and is not distinguishable between its head office and its branches in India is not tenable in view of the Explanation to Section 9(1)(i), and Double Taxation Agreement.
The CIT(A)-VII has considered this issue in the case of Barday Bank and held as under:
I have addressed myself carefully to the submissions made by the learned Counsel vis-a-vis the AO’s order on this score. In my considered opinion, the Nostro account is nothing but the bank account of the Indian branch in the head office and the interest carried on the balance in the Nostro account is, as rightly held by the AO, the income of the Indian branch, and it was in that spirit, the appellant-company had credited the same to the P&L a/c also.
In view of the above, a sum of Rs. 5,17,39,005 is added to the income of the assessee.
19. It was in this background that the AO made an addition of Rs. 5,17,39,005 to the returned income of the assessee-company. Aggrieved by the addition so made, assessee carried the matter in appeal before the CIT(A) but without any success. The assessee is not satisfied and is in appeal before us.
20. We may place on record the fact that, during the course of arguments before us, the assessee abandoned its plea that in terms of the India Germany DTAA (1996) 136 CTR (St) 50 : (1997) 223 LTR (St) 130, the income of Rs. 5,17,39,005 on account of interest received from head office and other branches of the assessee bank could not be taxed in the hands of the assessee. In response to our specific question, Shri Pardiwala stated at the bar that the assessee does not seek treaty protection and would like this grievance to be adjudicated upon in the light of the provisions of the IT Act. We also pointed out Special Bench decision in the case of ABN Amro Bank NV v. Asstt. Director of IT (2005) 98 TTJ (Kol)(SB) 295 : (2005) 97 ITD 89 (Kol)(SB) to the learned representatives and asked them as to what is the impact of the said decision on the dispute before us, and whether we are required to refer the matter to a larger Bench in case we have any reservations on the conclusions arrived at by the said Special Bench. Learned Counsel submits that ABN Amro’s decision was in the context of the claim of deduction and not in the context of an income situation, as is the case before us. It is also pointed out that the decision of the Special Bench was in the context of the treaty provisions and not in the context of the provisions of the Act. Learned Counsel, therefore, submits that ABN Amro decision (supra) has no bearing on the issue in appeal before us. Learned Departmental Representative points out that in ABN Amro Bank’s case (supra), the taxability of interest income from the head office and other branches was not even disputed by the assessee, and that the dispute was only with regard to claim of deduction for interest paid to head office and other branches. Learned Departmental Representative also thus submits that ABN Amro Bank’s case (supra), if at all, supports the case of the Revenue. We find that in para 10 of the ABN Amro Bank’s decision, it is noted that “the assessee is receiving interest from its head office and other branches outside India, which the assessee has credited to P&L a/c and offered for taxation”. In this view of the matter and in deference to the submission of the parties, we see no need to go further so far as ABN Amro Bank’s Special Bench decision is concerned. During the course of hearing, we also asked learned Counsel for the assessee for his opinion on the question as to what are the principles on the basis of which one can determine a’ non-resident taxpayer’s business profit which, for the purposes of Section 5(2)(b) of the IT Act, 1961, “accrues or arises…in India”. Learned Counsel for the assessee submitted that there are no judicial precedents on the issue but reiterated his detailed submissions in support of his stand about non taxability of inter branch incomes under the Indian IT Act. Learned Counsel’s emphatic submission is that an inter branch transaction is a transaction with itself and cannot lead to any income liable to be taxed or loss liable to be carried forward. These are self cancelling transactions, and are, resultantly, profit neutral. Reliance was placed on the decision of Hon’ble Calcutta High Court in the case of Berts Hartly Huett & Co. Ltd. v. CIT (supra), and on several Tribunal decisions following the same. Elaborate arguments are made in support of this line of reasoning. In response to our query that, in the absence of statutory provision providing mechanism for computing nonresident assessee’s business profits accruing or arising in India we could import the method of computing business profits of permanent establishments of nonresidents in the international tax treaties, learned Counsel submitted that profits of the assessee are to be computed under the provisions of the Act and the statutory provisions could not, therefore, be disregarded. No specific provisions were, however, pointed out in support of the contention that income earned by a permanent establishment from its principal general establishment is not liable to tax in the hands of the PE. Learned Departmental Representative, on the other hand, vehemently relied upon the orders of the authorities below, and justified the same. It was contended that to compute the profits of the Indian branch, it is essential to treat the same as a separate profit centre, and that, once the Indian branch is viewed is to be treated as a profit centre, the profits and losses earned by the Indian branch have to take into account the transactions that the Indian branch has entered into with the head office and the other branches. As regards learned Counsel’s reliance on the judgment of Hon’ble Calcutta High Court in the case of Betts Hartley Huett & Co. Ltd. (supra), learned Departmental Representative’s contention was that the said decision was rendered in altogether different context and would not have any application in the present case. It was on the strength of these arguments that we were urged to confirm the order of the authorities below and decline to interfere in the matter.
21. We have heard the rival contentions at considerable length, we have perused the material on record and we have given our thoughtful consideration to the factual matrix of the case as also the applicable legal position.
22. We consider it appropriate to first briefly deal with the scheme of the Act, so far taxation of profits earned by the branch offices of non-resident companies are concerned. Under Section 4 of the Act, it is total income of every ‘person’ which is taxable. Section 2(31), in turn, defines ‘person’ as including a ‘company’, which in terms of the provisions of Section 2(23A), includes a ‘foreign company’ as well. Section 6(4) of the Act lays down that a company, unless it is an Indian company or unless it is controlled or managed entirely from India, cannot be said to be resident in India. A foreign company, which is not wholly controlled or managed in India is, therefore, a non-resident so far as residential status under the Act is concerned. Section 5(2) further lays down that as far as a non-resident assessee is concerned scope of total income of such an assessee is confined to (i) an income which ‘accrues or arises in India’ or is ‘deemed to accrue or arise in India’, and (ii) an income which is received or is deemed to be received by or on behalf of such foreign company. This elementary analysis makes it clear that under the IT Act, so far as foreign companies are concerned, taxable unit is a foreign company and not its branch or PE in India, even though the taxability of such foreign companies is confined to (i) an income which ‘accrues or arises in India’ or is ‘deemed to accrue or arise in India’, and (ii) an income which is received or is deemed to be received by or on behalf of such foreign company.
23. A non-resident assessee may have several incomes accruing or arising to it inside India or outside India, but, so far as taxability under Section 5(2)(b) in India is concerned, it is restricted to incomes which accrue or arise, or is deemed to accrue or arise in India. The scope of this deeming fiction is set out under Section 9 of the Act. As for the income accruing or arising in India, an income which accrues or arises to a foreign enterprise company in India can essentially be only such a portion of income accruing or arising to such a foreign enterprise as is attributable to its business carried out in India. This business could be carried out through one or more branches or some other form of its presence in India. To determine income accruing or arising in India to a foreign enterprise (hereinafter referred to as ‘general enterprise’ or as ‘GE’), therefore, we have to compute income attributable to such branch(es) in India, or other form(s) of presence in India such as office, project site, factory, sales outlet etc, (hereinafter collectively referred to as ‘permanent establishment’ or TE’) of foreign enterprise. It takes us to the question as to what is the scope of income accruing or arising to a foreign company in India. That is the core issue in this appeal before us. As far as the expression ‘income deemed to accrue or arise in India is concerned, Section 9 of the Act elaborately deals with the same, but, as learned representatives agree, the expression ‘income accruing or arising in India’ is not defined anywhere in the Act, nor any judicial precedent is cited before us on the scope of this expression. We will, therefore, have to make our endeavour to find out the principles on the basis of which the income accruing or arising to a foreign enterprise in India can be determined.
24. It is important to bear in mind that, in terms of the provisions of the Indian IT Act, while the taxable subject is the foreign GE, it is taxable only in respect of the income, including business profits, which accrues or arises to that foreign GE in India. The Indian IT Act does not provide for any special mechanism for taxation of PE of a foreign enterprise, except taxation on presumptive basis for certain types of incomes such as under Sections 44BB, 44BBA, 44BBB, 44D, etc. It is ironical that while the Indian IT Act deals with the scope of income deemed to “accrue or arise” in India, at great length and visualizing possibly all sort of deeming fictions, there is not much elaboration about the scope of income which “accrues or arises” in India in the hands of a tax entity which has fiscal domicile abroad. Since there are no specific legislative provisions to keep pace with this aspect of increased cross-border commerce, by providing for mechanism to compute profits accruing or arising in India in the hands of the foreign entities, the profits attributable to Indian PE of foreign enterprise are required to be computed in terms of general provisions of the IT Act, and the normal accounting principles. Therefore, ascertainment of a foreign GE’s taxable business profits in India involves an artificial division of the overall profits of the GEbetween profits earned in India and profits earned outside India. Indian IT Act can only be concerned with the profits earned in India, and, therefore, a method is to be found to ascertain profits accruing or arising in India. The only way, in our humble understanding, it can be so done is by treating the Indian PE as a fictionally separate profit centre vis-a-vis the German GE. The very concept of computation of PE profits is created as a fiction of tax law in order to demarcate tax jurisdiction over the operations of a company in a country of which it is not a tax resident. Unless the PE is treated as a separate profit centre, it is not possible to ascertain the profits of the PE which, in turn, constitute profits accruing or arising to the foreign GE in India.
25. As a first step to the computation of business profits accruing or arising in India to the German GE, therefore, we have to compute the profits of the Indian branch or Indian PE of the German company.
26. Learned Counsel does not dispute the above proposition that business profits of the Indian PE are to be computed but he contends that in terms of the provisions of the Indian IT Act, no one can make profits by entering into transactions with oneself. It is contended that debiting or crediting one’s account does not alter this legal position, and that, therefore, irrespective of the head office account being debited for interest, it cannot be said that the Indian branch has earned any income by way of interest debited to the head office. Learned Counsel’s emphatic submission is that an inter-branch transaction is a transaction with itself and cannot lead to any income liable to be taxed or loss liable to be carried forward. According to the learned Counsel, these are self cancelling transactions, and are, resultantly, profit neutral.
27. In our humble understanding, the proposition that intra-organisation transactions are to be ignored for computing the business profits holds good only when profits of the organisation as a whole are to be computed, or when these transactions are domestic transactions within one single enterprise and within one tax jurisdiction. These intra-organisation transactions, which should more aptly be termed as ‘intra-organisation dealings’, have a significant impact on the determination of profits of the organisational unitswhether termed as PE, or by whatever other description.
28. Cross-border dealings within an enterprise, which necessarily concern at least two tax jurisdictions, however, need to be examined in a different perspectivethe perspective of ascertaining profits taxable in each such jurisdiction as also the perspective of ascertaining the income eligible for exemption, when tax credit in GE domicile tax jurisdiction is by way of exemption, in the GE domicile tax jurisdiction.
29. The computation of profits in each PE state i.e. each tax jurisdiction, thus has a dual role. On one hand, this computation decides the quantum of income on which source country can levy the tax, and, on the other hand, this computation also decides, generally speaking, the quantum of income for which tax credit is granted in the domicile country.
30. Viewed in this perspective, from the point of each source country, it is necessary that the profits of the PE are computed as independent units.
31. The profit neutrality theory from intra-organization transactions, within the organizational units, does not hold valid in a situation in which profits of an organizational unit, whether that unit is termed as a branch or as a PE or is given some other description, are to be computed. This is so for the simple reason that from the point of view of the taxable entity as a whole, an intra-organization transaction could be self cancelling or profit neutral transaction because an income by one of the organizational units of the entity could be an expenditure of the other organizational unit and, since, to work out overall profits of the entity, the profits and losses of all the units are to aggregated, the effect of the increased income of say ‘A’ unit will be offset by corresponding decrease in income of say ‘B’ unit. However, when one is to view the same transaction from the point of view of an organizational unit, situation materially changes. An income by ‘A’ unit by earning revenues from ‘B’ unit will result in enhancement of income of A unit and corresponding reduction in income of B unit. However, as far as computation of profits of A unit is concerned, it is immaterial whether there is corresponding adjustment in B unit or not. In computation of profits of ‘A’ unit, the adjustments in profits of ‘B’ unit are not at all relevant. That aspect of the matter would be relevant only for profits of the organisation as a whole were to be computed. Similarly, when the profits or losses of B unit are to be ascertained, it would be immaterial whether the expenditure by B unit can be construed as income of A unit or not, because, in that situation, the profits and losses of that unit are to be seen in isolation.
32. In contemporary business situations when economic activities of an organization are spread over several tax jurisdictions, and the right of each such tax jurisdictions is restricted to the profits accruing or arising to the PE in that jurisdiction, it is necessary that profits accruing or arising in such jurisdiction are computed correctly. This can be better explained by way of following diagram.
33. In the above diagram, PE-A, PE-B and PE-C respectively are three different organizational units of a GE in three different tax jurisdictions. PE-A represents the head office as an independent unit, and PE-B as also PE-C represent two independent branches. As an intra organization transaction, PE-A earns Rs. 1 million each from PE-B and PE-C, on account of services rendered to those two units. The impact of these transactions on different units of the GE, and the GE as a whole, will be as follows :
PE A Business profit up by Rs. 2 million
PE B Business profit down by Rs. 1 million
PE C Business profit down by Rs. 1 million
GE [2,000,000 + (-) 1,000,000 +(-) 1,000,000] = 0
i.e., profit neutral
It is thus clear that so far as the profits of the GE as a whole are concerned, the intra organization transactions are indeed profit neutral but, from the point of view of a PE, the intra organization transactions are not profit neutral.
34. In the cases in which foreign tax credit is given by exemption method in the GE domicile country, the quantum of such credit will indeed be affected by the intra organization transactions. Since PE-A, in the illustration above, is assumed to be in GE domicile country, for which only global GE profits are relevant, even this higher business profit does not result in an independent income being brought to tax. What will be taxable in GE tax jurisdiction is global business profit minus exemptions for incomes in other tax jurisdictions, if applicable, as tax credit. However, since we are examining the matter from the perspective of the PE, this aspect of the matter is not really relevant. What is important is that this theory of profit neutrality of intra organization transactions is certainly not true when these transactions are examined from the point of view of the organizational units. In the above example, as a result of the intra organization transactions, while the overall profits of the GE remain the same, the profits chargeable to tax in PE-B and PE-C tax jurisdictions are lowered by Rs. 1,000,000 each. Similarly, when a PE earns an income from the head office, the PE profits liable to tax in respective tax jurisdiction will go up, even as the overall profits, as a result of corresponding expense deduction in the hands of the head office, will remain the same. Nevertheless, the tax credit will be available for a higher amount of a foreign income in respect of which the domicile tax jurisdiction is to give relief. Viewed in this perspective, even if the income as a result of intra organization transaction is taxed in the PE tax jurisdiction, from the point of view of GE, normally this taxability does not increase the tax burden on the GE as a whole but only adjusts the rights of different tax jurisdictions in which the GE operates.
35. On a conceptual note, it is also important to bear in mind that based on a substance-over-form approach, the tax treatment applicable to these fictitious entities, such as a PE, should be the same as in the cases where non-residents establish separate legal entities in the form of subsidiaries. If both entities carry out similar economic activities, the choice of legal form should not lead to different tax results. The income of subsidiaries is determined separately based on the subsidiary’s revenues and deductible costs and expenses taking into account all incurred itemsthe taxation of PEs should be designed along the same lines. Therefore, while incomes of the PE should include all revenues, including revenues earned from other intra organization entities outside the respective tax jurisdiction, the expenses allowed as deductions from the profits of a PE should also be those that are actually borne by such a PE (i.e., that are incurred in the interest of the PE and not of another part/parts of the company) irrespective of whether or not the deductible amount should actually be reimbursed by the PE.
36. The question as to how to compute profits of the PE in cross border tax situations has received considerable attention of international tax community right from the initial days of development of international taxation law in the multilateral forums, as also attention of the judicial bodies in several countries. As far back as in 1933, League of Nations Draft Conventions had a specific provision for determining the profits attributable to a PE. This provision i.e. Article 3 of the Draft Convention, provided as follows :
If an enterprise with its fiscal domicile in one Contracting State has PEs in the other Contracting States, there shall be attributed to each PE the net business income which it might have been expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions. Such net income will, in principle, be determined on the basis of separate accounts prepared pertaining to such establishment. Subject to the provision of this Convention, such income shall be taxed in accordance with the legislation and international agreements of the State in which such PE is situated.
37. Even as the separate accounting approach was recognized in the above draft convention, it was also recognized that these intra organization dealings of the enterprise, i.e. between enterprise and its PE, may not always reflect the arm’s length transactions, as is evident from the following provision in the same Draft Convention :
The fiscal authorities of the Contracting State shall, when necessary, in execution of the preceding paragraph, rectify the accounts produced, notably to correct errors or omissions to re establish the prices or remuneration entered in the books at the value which would prevail between independent persons dealing at arm’s length.
38. What emerges from these facts is that, right from the initial stages, the accounting practices recognized that the intra organization dealings are to be taken into account, though at an arm’s length price, in computation of the PE profits. That confirms our understanding that in order to arrive at the true profits of a branch or the PE, howsoever you term it, the intra organizations (dealings) at the arm’s length price are to be taken into account. That is settled accounting position, so far as determination of profits of a PE are to be taken into account. No contrary accounting practice has been brought to our notice.
39. That takes us to the question whether, in the light of Hon’ble Calcutta High Court’s judgment in the case of Betts Hartley Huett & Co. Ltd. (supra), intra organization transactions are to be ignored.
40. The assessee in this case was a non-resident company with head office in London, and a branch in Calcutta. The assessee-company was engaged in the business of purchasing tea for its constituents abroad, and apart from reimbursement of expenses for making such purchases, a commission ranging from 1 per cent to 2 per cent of the value of tea was received by the company which was duly offered to tax in India. The assessee-company also purchased tea for its head office in London but did not charge any commission, in respect of the same, even as it recovered all the expenses incurred in connection with the purchases by billing the tea, supplied to the head office, at cost of purchases plus expenditure incurred thereon. On these facts, the case of the Revenue was that the commission, which was not charged by the branch office on sales to head office, accrued to the assessee’s head office in London. It was on this basis that the AO “estimated the profit attributable to purchase operations of the assessee’s London office in India, through the assessee, at 1.5 per cent of the value of tea sold and computed such profit at 7,827”. This addition was deleted by the AAC but when the matter reached the Tribunal, the Tribunal found that “there was no plausible reason why a commission was not charged on assessee’s sales to London office, and, to that extent, the London office did obtain a benefit due to its business connection in India and by not paying commission, this earning accrued or arose to the assessee because of its business connection in India” (
is, italicised in print, supplied by us). It was in the context of these facts that Hon’ble Calcutta High Court observed as follows:
It appears to us that both the assessee and Revenue had been proceeding on the basis that transactions between London head office of the assessee and its unit in India was transaction as between principal and principal. If this position is accepted then it cannot be held that any income arose in favour of the assessee directly or indirectly, the gain in London office being offset by the loss in Indian branch….
We note, however, that the parties all along did proceed under a misconception. In law, there cannot be a valid transaction between the branch office of the assessee in India and its head office in London. It is an elementary proposition that no person can enter into a contract with itself. Debiting or crediting one’s account cannot alter this legal position. If one unit of the assessee does not debit any commission to another unit of the same business, then it is difficult to follow how any saving has been effected by the business.
(emphasis, italicised in print, supplied by us)
41. These observations unambiguously show that what was added as income was added in the hands of the head office of the company i.e. GE, and not the Indian branch office. The addition was on account of a fictional benefit in the hands of the GE in respect of non-charging of commission by the Indian PE. It was in the backdrop of this vital fact that their Lordships noted that this intra-organisation transaction was profit neutral, from the point of view of organization as a whole, because even if this non-charging of commission was to be viewed as benefit to the head office, such a benefit or gain will stand neutralized by the loss to the India office on account of non-charging the commission. The matter was thus examined from the point of view of the GE as a whole and not from the point of view of ascertaining the profits of the Indian PE; rightly so, because, in that particular case, addition was made in the hands of the British GE and not the Indian PE. As rightly noted by a co-ordinate Bench of this Tribunal, in the case of Banque Indosuez v. Dy. CTT and vice versa (Mumbai ‘D’ Bench; order dt. 9th March, 1998), the above “remarks are in a different context, that is an assessee whose operations comprehend botha head office and a branch, and so, to our mind, are not applicable to the case like that of the present assessee in respect of whom the income of the PE, as a separate unit, has to be determined.” Although these observations were in the context of determination of profits of the PE in accordance with the provisions of the applicable tax treaty, we feel that these views are applicable with equal force on the question of determination ‘accrued or arisen in India’ under Section 5(2)(b) of the Act, which is nothing but the of profits of the Indian PE as an independent unit. The observations of the Hon’ble Calcutta High Court, on which so much reliance is placed by the assessee, are, therefore, not at all relevant when the matter in being examined from the point of view of a PE and while computing profits accruing or arising to a PE.
42. The underlined portions (italicised in print) of the extracts which we have reproduced from Hon’ble Calcutta High Court judgment, in the preceding paragraph, also highlight the fact that the concern of the Hon’ble Calcutta High Court was on the GE as a whole and not the PE in a particular tax jurisdiction.
43. It is also important to bear in mind the fact that what their Lordships observed was, beyond any dispute or controversy, in the context of scope of ‘income deemed to accrue or arise in India’ under Section 9(1) of the Act but we are at present not concerned with that aspect of the matter. Our endeavour in the present case is to find the principles on the basis of which business profits of the PE which constitute ‘income accruing or arising in India’ under Section 5(2) can be determined. On this issue, as learned representatives submit, there are no direct judicial precedents.
44. We cannot visualize any other method of accounting for determination of ‘income accruing or arising in India’ in the case of a foreign GE operating in India and on the facts of this case, except to treat its India operations as a hypothetically independent unit. For this reason, intra-organisation interest income will have to be taken into account to arrive at the ‘income accruing or arising in India’. For the reasons we are setting up separately in this order, any other approach to the computation of ‘income accruing or arising in India’ will result in manifest incongruities.
45. Learned Counsel has invited our attention to two decisions of the Tribunal to the effect that, following Hon’ble Calcutta High Court decision in the case of Betts Hartley Huett & Co. Ltd. (supra), interest income from head office cannot be taxed in the hands of the branch office. The main decision relied upon by the learned Counsel is order dt. 28th Aug., 1982 in the case of IAC v. Citibank NA which states that “it is well established principle of law that assessee cannot make profit from itself, and, therefore, the CIT(A) erred in trying to set up an enquiry for ascertaining the net profit or loss which the assessee might have earned from its branches abroad.” The observations made are perfectly valid in case profits of the entire business are to be ascertained, but the vital fact that was missed out was that the profit which can be taxed in India are only of the PE in India, and, therefore, is to be computed as if the PE is hypothetical independent.
46. In the Citibank’s case (supra), there is no discussion of any kind whether the profits to be taxed in India are Of the entire business or only the Indian branch. This aspect of the matter was, however, taken note of by a later Bench in the case of Banque Indosuez v. Dy. CIT and vice versa (Mumbai ‘D’ Bench; order dt. 9th March, 1998).
47. As rightly observed by the co-ordinate Bench of this Tribunal, in the case of Banque Indosuez v. Dy. CIT (supra), dealing with materially identical remarks made by the Hon’ble Calcutta High Court in the case of Betts Hartley Huett & Co. Ltd. (supra), “remarks are in a different context, that is an assessee whose operations comprehend botha head office and a branch, and so, to our mind, are not applicable to the case like that of the present assessee in respect of whom the income of the PE, as a separate unit, has to be determined.” We are in most respectful agreement with the views so expressed by the co-ordinate Bench.
48. In Banque Indosuez’s case (supra), there is a conscious decision by the Tribunal to the effect that the observations made by the Hon’ble Calcutta High Court will not be valid in a case where profits of the PE, as a separate unit, are to be considered. In Citibank’s case (supra), this aspect of the matter has not been considered at all. A decision is an authority only for what it actually decides and not even for what may logically follow from the decision. The issue whether or not the observations made by the Hon’ble Calcutta High Court will apply in a situation in which profits of the branch or the PE are to decided as an independent unit, has been specifically dealt with in Banque Indosuez’s case (supra) and we have to respectfully follow it. We cannot, and would not, decline to follow the law so laid down, on the ground that in an earlier decision of this Tribunal the Tribunal has held that the assessee cannot make profit from itself, particularly when having considered that proposition, the Tribunal, in Banque Indosuez’s case (supra), came to the conclusion that this proposition does not hold good in determination of profits of the branch office as an independent unit. We respectfully follow the Tribunal’s decision in Banque Indosuez’s case (supra).
49. Although these observations were in the context of determination of profits of the PE in accordance with the provisions of the applicable tax treaty, we are of the considered view that these observations are applicable with equal force on the question of determination ‘accrued or arisen in India’ under Section 5(2)(b) of the Act, which is nothing but the of profits of the Indian PE as an independent unit. Learned representatives have also agreed that it is an acceptable method to determine the profits accruing or arising in India, to the foreign bank, that the Indian PE is taken a profit centre. As a matter of fact, as we have discussed earlier in this order, there is no other way in accountancy or, for that purpose, even in commercial practices or in law in which the profits accruing or arising in India, in the hands of a tax entity not domiciled in India, can be determined. We have to treat the branches as hypothetically independent, and that is the underlying presumption in branch accounting methods in accountancy as well.
50. We may also refer to a rather recent decision of the Tribunal in the case of Societe Generate v. Jt. CIT (order dt. 24th May, 2004; Mumbai ‘B’ Bench) which refers to the decisions relied upon by the assessee and states that “the learned Departmental Representative has not been able to put forth any decision on the point to rebut the claim of the assessee” and that “the case laws cited by the assessee squarely cover the issue in favour of the assessee”. There is no discussion of any kind about the precise issue before the Tribunal or whether the matter has been examined from the perspective of the PE or the GE as a whole. The Tribunal decision in the case of Banque Indosuez (supra) was obviously not brought to the notice of the Tribunal, and the Tribunal had no occasion to even take into account the fact that only PE profits were to be taxed in India, and not that of the GE as a whole, and, therefore, profit neutrality theory could not have applied in this case.
51. In this background, it is interesting to note the following observations made by the Hon’ble Gujarat High Court in the case of Gujarat State Co operative Bank Ltd v. CIT :
As per the settled legal position, a decision is an authority for what it actually decides and not necessarily for what logically follows from it. Equally well settled is the principle that a decision to be law under Article 141 must not be a mere conclusion by which the case is disposed of. Because, a conclusion, mere conclusion, may be on the facts, it may not and does not necessarily involve consideration of law….The contentions raised by the Revenue in the present case…was not challenged in…(that) case.
52. Hon’ble Bombay High Court, in the case of CIT v. Sudhir Jayantilal Mulji has observed as follows :
…It is well settled that ratio of a decision alone is binding, because a case is an authority for what it actually decides and not what may come to follow from some observations which find place therein. The ratio of a decision has to be distinguished from the propositions assumed by the Court to be correct for the purpose of disposing of the particular case, because it is the ratio not the propositions which are relevant and binding.
53. In the case of Blue Star Ltd. v. CLT , Hon’ble Bombay High Court has observed :
…as observed by Earls of Halsbury LC in the case of Quinn v. Leathern (1901) AC 495 (HL), every judgment must be read as particular facts proved or assumed to be proved, since the generality of expressions which may be found there are not intended to be the expositions of the whole law, but governed and qualified by the particulars facts of the case in which such expressions are found and a case is only an authority for what it actually decides…
54. It is important to bear in mind the fact that in Societe Generale’s case (supra), no law is laid down. The co-ordinate Bench has proceeded on the assumption, which turns out to be a wrong assumption, that there is no judicial precedent contrary to Citibank’s case (supra) as the Departmental Representative did not invite attention of the Tribunal to its later decision in the case of Banque Indosuez (supra). Based on this erroneous assumption, the Tribunal followed the order of the co-ordinate Bench to which its attention was invited by the counsel of the assessee. All that the Tribunal decided was to follow the co-ordinate Bench, and there cannot be any questions on correctness of this approach. We respect and follow the same approach. As we have noted earlier, Hon’ble Gujarat High Court is of the view that when the consideration of law is not involved, even Hon’ble Supreme Court’s decision which is “a mere conclusion by which the case is disposed of” does not become law under Article 141 of the Constitution of India. When such are the views about the decisions of the Hon’ble Supreme Court, it is futile to contend that merely because Tribunal arrived at a particular conclusion without actual consideration of the legal questions involved, on clearly erroneous facts as presented by the parties and accepted by the Tribunal to be correct in good faith, this Tribunal decision lays down the law which is binding on its co-ordinate Benches. Contrary decisions were not brought to the notice of the Tribunal and the matter was taken as a ‘covered matter’. It is a mere conclusion arrived at by the Tribunal and no legal precedent is set out. It is also not clear whether the Tribunal was conscious that the matter is to be considered from the limited point of view of the PE or whether the Tribunal proceeded on the basis that it is in seisin of the GE profits as a whole. In view of the judicial precedents discussed above, we do not have the liberty to treat this Tribunal decision as a binding precedent in respect of a question which was not even considered by the Tribunal. The assessee thus derives no advantage from Tribunal’s decision in the case of Societe Generale’s case (supra).
55. Both the Tribunal decisions relied upon by the learned Counsel refer to Hon’ble Calcutta High Court’s judgment in the case of Betts Hartley Huett & Co. Ltd. (supra). Hon’ble Calcutta High Court’s judgment was in the context of taxability under Section 9(1) of the Act in the hands of the foreign GE as a whole, whereas in the Indian PE situations we are essentially concerned with the profits accruing or arising in India under Section 5(2)(b) of the Act. This position is unambiguous from the following observations made in the Hon’ble High Court’s judgment itself:
… Learned Counsel for the assessee, contended at the hearing that…there was no scope for the application of Section 9(1) of the Act…(learned Counsel) contended further that in the instant case the income, if any, in fact accrued or arose in India, and there was no scope of application of Section 9 which provided that certain incomes, though not accruing or arising in India, would be deemed to accrue or arise in India.
56. The fact that their Lordships were examining the matter from the point of view of the GE as a whole and not one of its unit is also evident from the following observations made by their Lordships in their conclusions :
…it cannot be held that any income arose in favour of the assesses either directly or indirectly; the gain in London office being offset by the loss incurred in Indian branch.
57. The Tribunal orders, relied upon by the learned Counsel, inadvertently did not take these vital facts into account. This aspect of the matter was, however, taken into account by another Bench, in the case of Indosuez Bank (supra), which did point out that the profit neutrality of self to self transactions did not apply to a situations in which profits of a branch are being considered in isolation. We agree with this decision, and are also alive to the fact that both the Tribunal decisions relied upon by the learned Counsel of the assessee did not deal with this aspect of the matter at all. The Calcutta High Court decision in the case of Betts Hartley Huett & Co. Ltd. (supra), for the reasons set out above and as also noted in the case of Banque Indosuez (supra), was not at all applicable on the facts before the Tribunal. Bearing in mind this fact and the other elaborate discussions discussed earlier in this order, as well as the esteemed views of Hon’ble Andhra Pradesh High Court in the case of CIT v. B.R. Constructions (1993) 113 CTR (AP) 1 : (1993) 202 TTR 222 (AP), these Tribunal decisions relied upon by the learned Counsel cannot be said to have much of a precedence value. In Tribunal’s decision in the case of Indosuez Bank (supra), on the same set of material facts as before us now, the same Calcutta High Court judgment was distinguished on principle and, therefore, found to be not applicable.
58. As has been said by the Hon’ble Supreme Court in the case of Padmasundara Rao (Deed.) and Ors. v. State of Tamil Nadu and Ors. (2002) 176 CTR (SC) 104 : (2002) 255 TTR 147 (SC), “Courts should not place reliance on the decisions without discussing as to how the factual position fits in with the fact situation of the decision on which reliance is placed” and that “there is always peril in treating the words of a speech or judgment as though they were words in the legislative enactment, and it is to remembered that judicial utterances are made in the setting of facts of a particular case…”. Their Lordships further observed that “Circumstantial flexibility, one additional or different fact may make a world of difference between conclusions in two cases.” The same principle is reiterated time and again by the Hon’ble Supreme Court. Hon’ble Delhi High Court in the case of S.R.F. Finance Ltd. v. CBDT (1994) 122 CTR (Del) 431 : (1995) 211 TTR 861 (Del) summing up the principles laid down by the Hon’ble Supreme Court, has observed that “it is well settled rule of construction that judgments must be read as a whole and observations from the judgment should be considered in the light of questions which were before the Court.” Hon’ble Supreme Court itself, in the case of Mumbai Kamgar Sabha v. Abdulbhai Faizulbhai , has, inter alia, observed as follows :
It is trite, going by Anglophonic principles that a ruling of superior Court is binding in law. It is not of spiritual. sanctity but is of ratio wise luminosity within the edifice of facts where judicial plays the legal flame. Beyond those walls and de hors the milieu, we cannot impart eternal vernal value to the decision, exalting the doctrine of precedence into prison house of bigotry, regardless of varying circumstances and myriad developments; realism dictates that a judgment has to be read, subject to the facts directly presented for consideration and not affecting those matters which may be lurking in the dark.
59. The context in which the observations were made by Hon’ble Calcutta High Court, as we have discussed above, was entirely different vis-a-vis the issue before us. Hon’ble Calcutta High Court concern addressed itself to the profits of the foreign GE under Section 9 of the Act, as against the income accruing or arising to a domestic PE under Section 5(2) of the Act. Their Lordships considered profit neutrality from the point of view of business as a whole i.e. GE as a whole, but our concern is only with the impact of intra organization transactions from the perspective of PE. The observations of Hon’ble Calcutta High Court, on which so much emphasis has been made by the learned Counsel, are, therefore, not relevant so far as the issue before us is concerned.
60. Since learned Counsel for the assessee has fairly admitted that there is no judicial precedent on the scope of income ‘accruing or arising’ under Section 5(2)(b), with which we are presently concerned, it is not really necessary to address ourselves to those decisions. In any event, we are in considered agreement with the stand taken in the Tribunal’s later decision in the case Indosuez Bank (supra).
61. The scope and nature of the expression ‘PE’ has been clarified in Section 92F, introduced w.e.f. 1st April, 2002. This section was inserted to define certain expressions, in the light of the introduction of transfer pricing regulations, and, in our considered view, these definitions are no more than clarificatory in nature. Section 92F(iii) defines ‘PE’ as a “fixed place of business through which the business of the enterprise is wholly or partly carried on.” Section 92F(iii) recognizes a PE also as an enterprise. The effect of this position is that the transactions between a foreign company and its PE in India is to be viewed as an international transaction between two enterprisesbetween two associated enterprises though, in the light of provisions of Section 92A. Now, in this light, let us take a look at the provisions of Section 92(1) which are as follows :
92(1) Any income from an international transaction shall be computed having regard to the arm’s length price.
Explanation : For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising torn an international transaction shall also be determined having regard to the arm’s length price.
62. Section 92(1) r/w Explanation thereto, thus makes it clear that interest transaction between head office of a foreign company i.e. GE and its PE in India i.e. PE are to be accounted as income on arm’s-length price. Accordingly, if an Indian PE receives interest from the head office @ 2 per cent per annum, and the arm’s length interest price is, say, @ 5 per cent per annum, the income from this transaction is to be computed @ 5 per cent per annum. Transfer pricing provisions cannot, and do not introduce new incomes in the tax net, but only provide that incomes from international transactions are to be computed at arm’s length price. The fact that head officebranch office interest transactions are also to be computed as income on the basis of transfer pricing provisions, only confirms, as in our considered view is the correct legal position, that interest earned by the branch office from head office is a taxable event, so far as taxability of branch office is concerned.
63. We may also refer to the Expln. 2 to Section 80HHC(2)(b) of the IT Act. Under this legal provision, when goods or merchandise are transferred by an assessee to its foreign branch, office, warehouse or establishment (hereinafter collectively referred as ‘foreign PE’) and are sold from such foreign PE, such transfer shall be deemed to be exports and the value of the goods or merchandise stated at the shipping bill will be treated as sale proceeds thereof. It is thus clear that intra organization transactions are also taken into account for the granting of tax incentives to the assessee. When for the purposes of tax incentives PE-GE independence is maintained, taxability of an income must also proceed on PE-GE independence. When this proposition was put to the learned Counsel, he submitted that taxable event in this case is the sales by the foreign PE and not the transfer by the Indian GE. If Indian GEforeign PE transfer takes place in ‘x’ year, but sales by the foreign PE takes place in ‘x + 1’ year, the Section 80HHC computation in ‘x + 1 year will account for this Section 80HHC deduction. We agree that this is correct position but in our opinion, for the present purposes, this aspect is not really relevant. It is only when sales by the foreign PE takes place, it can be taken to the income of the PE which is includible in the income of the Indian GE. Therefore, the year in which income is accounted for, the tax incentive by way of increased deduction under Section 80HHC is to be granted. One must bear in mind that Section 80HHC is not a charging section but is an incentive section.
64. What is important, however, in this aspect of the scheme of Section 80HHC is the way in which profit in different tax jurisdiction is separated and the way in which hypothetical independence of the PE is maintained for that purpose, even under the IT Act.
65. To illustrate, if cost of a product is Rs. 10, the same is transferred to the foreign branch at Rs. 20 and is finally sold by the foreign branch at Rs. 40, the profit from export activity, eligible for deduction under Section 80HHC, will be taken at Rs. 10. The remaining profit of Rs. 20 is includible in profit of the foreign PE on which Section 80HHC is not available. In this manner, the profit of Rs. 30, which is the actual profit on sale of export of this product, is divided in two tax jurisdictions.
66. Explanation 2 to Section 80HHC(2)(b), therefore, does not deal with a taxable event but it does surely, and very unambiguously, highlights the GE-PE independence so far as computation of profits are concerned.
67. If we are to apply the same logic on the case before us, and we assume that the costs of funds to the Indian PE is x, it is given to the head office at interest consideration of y, and these funds are finally given to the customers for the consideration of z, the taxable profits or losses in these two jurisdictions will be as follows:
PE jurisdiction : y - x
GE jurisdiction : z - y
Total profits : (y - x)+(z- y) =
z - x
68. It is also to be borne in mind that export of goods or merchandise is a case in which goods and merchandise can be identified. In case of lending of money which goes to a common pool, out of which business activities, including that of granting of loans and advances, are carried out, this kind of identification cannot be done. Let us also not forget that Expln. 2 to Section 80HHC(2)(b) only deals with a Indian GEforeign PE situation and not foreign GEIndian PE situation as is the case before us. The underlying principle of this aspect of the scheme of Section 80HHC is, however, unambiguous. In case of HOBO transactions, the GEPE independence is to be recognized for the purpose of allocating profits attributable to the PE and the GE and the intra organization transactions are to be accounted at the price at which the transfer between the two has taken place, unless, of course, the price itself is found to be incorrect. From this point of view also, the income earned by the Indian PE as interest earned from foreign GE is to be taxed in India.
69. There is one more way of looking at the issue before us. The assessee has admittedly lent monies to the head office, in consideration of which interest credits are received. These funds are acquired by the assessee by incurring certain costs, such as interest paid to the depositors as also establishment costs. The use of these funds, however, is outside Indian tax jurisdiction and the income earned from these funds, therefore, is exigible to tax outside Indian tax jurisdiction. When the revenues generated are not taxable in India, the expenditure incurred for earning these revenues also cannot be allowed as deduction of income exigible to tax in India. The entire costs of acquiring these funds should then cease to be deductible as an expense for the purposes of business in India.
70. To illustrate the above, let us take a case in which a German GE raises funds in India and transfers the same to its head office abroad for end use in, say, business of granting loans and advances. The entire costs of funds, being interest paid by the PE and the establishment costs will then be tax deductible in India. This will result in huge losses being computed as profits attributable to the PE in India, since revenues earned from the end use of funds will be revenues of the German GE and the revenues earned as interest from head office will not be taxable as income in the hands of the Indian PE. On the other hand, the entire revenue from interest use will be taxable in the hands of the head office. In effect, in the present case, the taxability of income will stand shifted from India to Germany, and the allowability of deduction will stand shifted from Germany to India. In our considered opinion, expenditure can be allowed as deduction only in the tax jurisdiction in which the corresponding income is taxed, or, by the same logic, income is to be taxed in the same tax jurisdiction in which corresponding deduction is to be allowed. Where economic activities to earn an income are spread over two tax jurisdictions, the income can be suitably appropriated in those two jurisdictions, and the provision for intra organization interest charge does precisely that. If, however, we are to uphold the contention of the assessee, it will result in manifest absurdity. The taxability of income will be in the GE country i.e. Germany, while allowability of expense will be in PE country i.e. India. That is clearly an unintended absurdity, and an interpretation which leads to such incongruous results cannot meet any judicial approval.
71. For all these reasons, we are not persuaded by the learned Counsel’s arguments that since no one can be expected to make profits out of transactions with himself, intra organization transactions are to be ignored for the purposes of computing profits accruing or arising, to an Indian PE of a foreign company, under Section 5(2)(b) of the Act. In our understanding, for the purposes of computing profits of a PE, the intra organization transactions are to be taken into account as long as these transactions are real and bona fide transactions. It is not the assessee’s case that the interest income from the head office is without any consideration or without sufficient consideration. In other words, fact of or correctness of interest earnings from head office are not in dispute. Therefore, in our considered view, the interest earnings from the head office are to be taken into account for the purposes of computing profits arising in or accruing in India. We, therefore, reject the contentions of the assessee.
72. As we part with this issue in appeal before us, we may add that we are alive to the fact that our decision hereinabove can possibly result in an incongruity inasmuch as while a foreign bank operating in India will be taxable in India in respect of the interest it earns from its head office and branches abroad, no deduction will be available, in the light of Special Bench decision in the ABN Amro Bank’s case (supra) to the foreign banks in respect of interest incurred to head office and branches abroad. In fact, it was for this reason that we did seek comments of the parties on as to why this appeal should not be referred to a larger Bench and let the law be settled in a holistic manner by taking into account all aspects of the intra-organisation dealings, and unfettered by the earlier decisions of this Tribunal. Learned Counsel’s emphatic opposition to this suggestion was on the ground that the assessee bank has already wound up its operations in India and it does not want to delay finalization of its tax liability as the constitution of larger Bench will result in, that the case before us only deals with an income situation under the Act while ABN Amro Bank’s case (supra) deals with an expense situation under the tax treaty, and, that, the issue decided by the Tribunal in ABN Amro Bank’s case (supra) does not arise in this appeal at all. Learned Departmental Representative also, equally emphatically, submitted that the issue before us does not need to be referred to a larger Bench. It was also submitted that there have been no judicial precedents, either from Tribunal or even the higher judicial forums, on the scope of ‘income accruing or arising in India’ under Section 5(2)(b) and, therefore, there is no question of any fetters of the earlier decisions. It was in this backdrop that the matter was decided by us on merits. This decision, therefore, should only be treated as an authority for the issue actually decided by us. Subject to these observations and for the reasons set out above, the plea of the assessee is rejected.
73. Having held so, we may also add we have not addressed ourselves to the reasoning adopted by the CIT(A) as he has proceeded to examine the scope of deeming fiction of Section 9, without addressing himself to the basic taxability of ‘income accruing or arising in India’ under Section 5(2)(b) of the Act. The AO had categorically observed that if the branch and head office are to be viewed as one and the same thing, then there was no reason to file ‘return in respect of India operations’, and had thus proceeded on ‘hypothetical independence’ of the PE for ascertaining the profits accrued or arisen in India. The AO had also observed that it was accepted international tax law practice that income “accruing or arising” in a country is taxed in that country. Therefore, the basic case of the Revenue was that the interest earned from the head office constituted ‘income accruing or arising in India’. The CIT(A) however proceeded to examine the scope of deeming fiction without bothering to first examine whether or not the impugned income constitutes income ‘accruing or arising in India’. In our considered view, the discussions by the CIT(A) on the scope of Section 9 are not really relevant, or rather premature, on the facts of this case. The question of deeming fiction could have been relevant only when the Revenue’s case did not succeed on the basic chargeability of ‘income accruing or arising’ in India. We had, therefore, directed the parties to address us on the scope of ‘income accruing or arising’ in India under Section 5(2)(b) of the Act, which was also the issue before the AO, and whether or not the interest received by the PE from the head office will constitute his income ‘accruing or arising in India’. Both the parties have been heard on this aspect of the matter at considerable length and we have arrived at our conclusions by considering rival contentions as also by considering applicable legal position as well as factual matrix of the case. Since the case of the assessee fails on the scope of the main chargeability section of income ‘accruing or arising in India’ under Section 5(2)(b) of the Act, there is no need to deal with the scope of the deeming fiction of income deemed to accrue or arise in India under Section 9 of the Act. We have held the income to be ‘accruing or arising in India’ and therefore, it is not really relevant whether the income can be treated as ‘deemed to accrue or arise in India’. While we, therefore, approve the conclusions arrived at by the CIT(A), we do not even see the need to deal with the reasoning adopted by the CIT(A). Our reasoning may be different, but conclusion is the same as arrived at by the CIT(A). We approve the conclusion arrived at by the CIT(A), so far as this grievance of the assessee is concerned, and decline to interfere in the matter.
74. Ground No. 2 is, accordingly, dismissed.
75. In the third ground of appeal, the grievance raised by the assessee is as follows:
Applicability of minimum alternate tax as per the provisions of Section 115JA of the Act.
The CIT(A) erred in holding that the provisions of Section 115JA apply to your appellant.
76. As far as this issue is concerned, having heard the rival contentions and having perused the material on record, we find that Hon’ble Authority for Advance Rulings (AAR), in the case reported as P. No. 14 of 1997, XYZ, In IB (1998) 148 CTR (AAR) 417 : (1998) 234 TTR 335 (AAR), had an occasion to consider the issue whether or not the minimum alternate tax under Section 115JA is applicable on the foreign companies. In the said ruling, after an elaborate analysis of the legal position and considering all the objections of the assessee which are materially the same as raised before us by the assessee now, the Authority came to the conclusion that Section 115JA applies on the foreign companies as well. We have perused the said ruling given by the Hon’ble AAR, and we find ourselves in most respectful agreement with the views expressed by the Hon’ble AAR. We adopt the reasoning given by the Hon’ble AAR, and, accordingly, hold that Section 115JA in principle applies to the foreign companies as well. In any event, words employed in Section 115JA are very clear and unambiguous. Section 115JA applies to a company which includes a foreign company as is the assessee before us. Learned Counsel, however, invites our attention to various factors which, according to the learned Counsel, demonstrate that the intention of legislature was to extend the provisions of Section 115JA only to domestic companies. According to the learned Counsel, it is nothing more than an unintended omission that the legislature specifically did not so provide. We are, however, not persuaded by these submissions, nor do we wish to go into the intent of legislature, as learned Counsel urges us to do, and to supply the casus omissus based on our reading of the intent of the legislature. It is not for to us to supply the casus omissus, even if there be any. While on this issue, we see no need to say anything more than quote, with approval, following observations made by one of us (i.e., the AM) while articulating Kolkata ‘B’ Bench of this Tribunal in the case of Tata Tea Ltd. v. Jt. CIT (2003) 78 TTJ (Kol) 646 : (2003) 87 ITD 351 (Kol):
Casus omissus, which broadly refers to the principle that a matter which has not been provided in the statute but should have been there, cannot be supplied by us, as, to do so will be clearly beyond the call and scope of our duty which is only to interpret the law as it exists. Hon’ble Supreme Court, in the case of Smt. Tarulata Shyam and Ors. v. CIT has observed:
We have given anxious thought to the persuasive arguments.., (which) if accepted, will certainly soften the rigour of this extremely drastic provision and bring it more in conformity with logic and equity. But the language of sections … is clear and unambiguous. There is no scope for importing into the statute the words which are not there. Such interpretation would be, not to construe, but to amend the statute. Even if there be a casus omissus, the defect can be remedied only by legislation and not by judicial interpretation….To us, there appears no justification to depart from normal rule of construction according to which the intention of legislature is primarily to be gathered from the words used in the statute. It will be well to recall the words of Rowlatt, J. in Cape Brandy Syndicate v. IRCs (1921) 1 KB 64 (KB) at p. 71, that : “…in a taxing Act one has to look at merely what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly at the language used.” Once it is shown that the case of the assessee comes within the letter of law, he must be taxed, however great the hardship may appear to the judicial mind to be.
Even in the case of National Taj Traders (supra), relied upon by the assessee, their Lordships of Hon’ble Supreme Court have referred to, with approval, Maxwell on Interpretation of Statutes’ observation that “A case not provided for in a statute is not to be dealt with merely because there seems no good reason why it should have been omitted, and that the omission appears in consequence to have been unintentional”. Their Lordships then observed that “In other words, under the first principle, a casus omissus cannot be supplied by the Court except when reason for it is found to be in the four corners of the statute itself but at the same time a casus omissus should not be readily inferred and for that purpose all the parts of a statute or section must be construed together and every clause of a section should be construed with reference to the context and other clauses thereof so that the construction to be put on a particular provision makes a consistent enactment of the whole statute”. In the present case, the reason for casus omissus is admittedly not in the statute itself but, as we could make out, only because, according to the assessee, there is no good reason for excluding the existing EOUs from the benefit of extended period. Even going by the principles enunciated in National Taj Trader’s case (supra), this cannot be a reason enough for the casus omissus. It is not that interpreting the time-limit in Section 10B as ‘ten consecutive assessment years’ w.e.f. 1st April, 1999 would, to use the words approved by their Lordships, ‘defeat the obvious intention of legislation and to produce a wholly unreasonable result’, but, even according to the assessee, only that there is no good reason as to why this amendment was not effective from 1st April, 1998 or, to put it definitely, such a retrospective operation would have been more in harmony with the perceived objects of the amendment. By no stretch of logic, such a situation could be a fit case for inferring the omission. It has been recognized by the Hon’ble Supreme Court, in the case of Petron Engineering Construction (P) Ltd v. CBDT that in respect to a matter provision of which may have been desirable but has not been really provided by the legislature, the omission cannot be called a defect of the nature which can be cured or supplied by recourse to the mode of construction advocated by Lord Denning in Seaford Court Estates Ltd. ‘s case (supra).
9. As for the Lord Denning’s observations in the Seafoid Court Estates Ltd. (supra), which have been heavily relied upon by the learned Counsel, we wish to make some observations. The House of Lords itself, in a later judgment in the matter of Magor & St. Mellons Rural District v. Newport Corporation (1951) 2 All ER 839, did not approve the proposition advanced by Lord Denning. It is interesting to note the articulate expressions of Lord Simonds, supporting the majority view and at p. 841 of All England Report, Vol. 2 (1951), unequivocally and categorically rejecting Lord Denning’s theory on the relevance of intent of legislature :
My Lords, the criticism which I venture to make of the judgment of learned lord justice (Denning LJ) is not directed at the conclusion he has reached. It is after all a trite saying that on questions of construction different minds may come to different conclusions….But it is on the approach of lord justice to which is a question of construction and nothing else. I think it desirable to make some comment, for, at a time when so large a proportion of the cases that are brought before the Courts depend on the construction of modem statutes, it would not be right for this house to pass unnoticed the propositions that the learned lord justice lays down for the guidance of himself and presumably others…
…The part which is played in judicial interpretation of a statute by reference to the circumstances of its passing is too well known to need restatement….The duty of the Court in to interpret the words that the legislature has used. Those words may be ambiguous, but, even if they are, power and duty of the Court to venture outside them on a voyage of discovery are strictly limited; see, for instance, Assam Railways & Trading Co. Ltd. v. IRC (2) and particularly the observations of Lord Wright (1935) AC 458…
…What the legislature has not written, the Court must write, and fill in the gaps. This proposition, which restates in a new form the view expressed by the lord justice in the earlier case of Seaford Court Estates Ltd. v. Asher (to which lord Justice himself refers) cannot be supported.
…It appears to me to be naked usurpation of legislative function in the thin guise of interpretation and it is less justifiable when it is guesswork with what material the legislature would, if it had to discover the gap, have filled it in. If a gap is disclosed, the remedy lies in an amending Act…
Lord Denning’s aggressive definition of the power of the Courts, so far as question of casus omissus is concerned, was severely criticized by Lord Simonds and other law lords in the above case. Lord Morton observed that “These heroics are out of place” and pointed of Lord Tucker “Your Lordships would be acting in a legislative rather than judicial capacity of the view put forward by Denning LJ were to prevail” (at p. 850). As observed in Cross Statutory Interpretation (2nd Edition, at p. 45), the current tendency among English Judges would appear to incline away from the Denning approach. These views are also echoed by Hon’ble Supreme Court of India from time to time. In the case of State of Kerala v. Mathai Verghese , Hon’ble Supreme Court has taken a view that the Court cannot reframe the legislation for the very good reason that it has no power to legislate. In Jumma Masjid v. Kodlamaniandra AIR 1962 SC 847, at p. 850 Hon’ble Supreme Court referred to, with approval, Lord Loreburn’s observation, “We are not entitled to read words into an Act of Parliament unless clear reasons for it is to be found within the four corners of the Act itself.” Vickers Sons & Maxim Ltd. v. Evans (1910) AC 444 (HL), at p. 445. Lord Simonds rejection of Denning’s approach was cited, with approval, by Hon’ble Supreme Court in the case of Punjab Land & Development Corporation v. Presiding Officer . We leave it at that.
77. Learned Counsel’s next argument is that even if we are to opine that, in principle, the provisions of Section 115JA extend to the foreign companies, the provisions of Section 115JA will not apply to the facts of this case, in view of the provisions of the India Germany DTAA (1996) 136 CTR (St) 50 : (1997) 223 TTR (St) 130. Learned Departmental Representative’s objection is that since the assessee has specifically given up his option to be assessed to tax as per the provisions of the tax treaty, it cannot be open to the assessee to seek protection of the tax treaty for the purposes of levy of minimum alternate tax (MAT, in short) under Section 115JA. This kind of selective treaty protection, according to the learned Departmental Representative, is not permissible in law. It is also contended that the levy of MAT under Section 115JA is an integral part of the income computation process, and once the assessee has himself opted that his income be computed in accordance with the provisions of the Act, he cannot turn back and seek treaty protection for the limited purposes of applicability of MAT. For the reasons we shall now state, it is not necessary to go any deeper so far as this line of argument is concerned.
78. Undoubtedly, in a case where the Government of India has entered into a tax treaty with a foreign country, then in relation to an assessee on whom such tax treaty applies, the provisions of the IT Act apply only to the extent these are more beneficial to the assessee. However, once assessee himself abandons his option to be assessed to tax in accordance with the provisions of the tax treaty, as is the situation before us, it cannot be open to assessee to go back for the treaty protection on one aspect of the tax assessment i.e. on applicability of MAT under Section 115JA of the Act. Either an assessee is to be assessed to tax on the basis of the provisions of the tax treaty or not. In our considered view, the assessment of income cannot be split into several segments and then the applicability of treaty provisions, vis-a-vis tax law provisions, cannot be separately considered for each segment. Liability for MAT under Section 115JA is an integral part of assessee’s assessment of income, and, once the assessee chooses to be assessed as per provisions of the Act, in preference over the provisions of the tax treaty, it cannot be open to the assessee to seek treaty protection in respect of one of the aspects of the assessment of the income i.e. applicability of MAT under Section 115JA. We, therefore, uphold Revenue’s contention to the effect that the provisions of the applicable tax treaty cannot be relied upon by the assessee for the limited purposes of claim of non-applicability of Section 115JA on the facts of this case.
79. Accordingly, third ground of appeal is dismissed.
80. That leaves us with fourth and last grievance of the assessee which is as follows :
Treatment for provision of bad debts (of Rs. 4,27,75,000) while computing the book profit under Section 115JA of the Act
The CIT(A) erred in holding that the amount representing ‘provision for bad debts’ should be added to the net profit while computing the book profit under Section 115JA of the Act.
81. In the course of assessment proceedings, the AO, for the purposes of computing liability under Section 115JA of the Act, added back the ‘provision for bad debts’ amounting to Rs. 4,27,75,000 to the profit as per the P&L a/c. In effect, the AO held that the aforesaid provision constitutes ‘a provision made for meeting the liabilities, other than ascertained liabilities’. Aggrieved by the stand so taken by the AO, the assessee carried the matter in appeal before the CIT(A) but without any success. The CIT(A) upheld the action of the AO by relying upon the judgment of Hon’ble Madras High Court in the case of Dy. CTT v. Beardsell Ltd. (2000) 162 CTR (Mad) 467 : (2000) 244 TTR 256 (Mad). The assessee is not satisfied and is in further appeal before us.
82. We find that this issue is covered in favour of the assessee by decisions of the co-ordinate Benches in the cases of Asstt. CTT v. J.G. Vacuum Flasks (P) Ltd. (2002) 83 LTD 242 (Pune) and Maharashtra State Electricity Board v. Jt. CTT (2002) 77 TTJ (Mumbai) 33 : (2002) 82 JTD 422 (Mumbai). Learned Departmental Representative, however, has vehemently relied upon the orders of the authorities below and justified the same.
83. We see no reasons to take any other view of the matter than the view so taken by the co-ordinate Benches. As for the decision of the Hon’ble Madras High Court in the case of Beardsell Ltd. (supra), the same has been duly considered and distinguished by the co-ordinate Bench in the case of J.G. Vacuum Flasks (P) Ltd. (supra). As held by the co-ordinate Benches, provision for bad debts so made by the assessee is not for meeting any liability but in effect to provide for diminution in the cost of the assets. We are in considered agreement with the conclusions so arrived at by the co-ordinate Bench. In any event, there is no contrary decision so far as this aspect of the matter is concerned.
84. Respectfully following the decisions of the co-ordinate Benches, we direct the AO to delete the adjustment for ‘provision for bad debts’ amounting to Rs. 4,27,75,000 so far as computation of liability under Section 115JA is concerned. The assessee gets the relief accordingly.
85. The assessee thus succeeds so far as fourth ground of appeal is concerned.
86. In the result, the appeal is partly allowed in the terms indicated above.